Banks want this and more

The thinking inside all the big four banks is that they want to hold back from borrowers more than this latest official rate cut.

In fact, they want to hold back part or all of this one plus at least some of the next one to maintain their margins and build in some buffer for rising costs ahead as the European crisis makes their funding more expensive.

If they had their way and were not in the spotlight, the big four would pass on only 25 or 35 basis points of the Reserve Bank of Australia’s total 50 points of cuts so far, giving them some room to pass on in full the next cut should the central bank deem one necessary in February.

Of course, the backlash to with­holding so much from borrowers would be ballistic, not to mention from Treasurer
Wayne Swan
, who upped the pressure on the big four yesterday.

But ignoring the simplistic and ­predictable bleating of politicians and the umbrage industry, followers of game theory will discern two separate, interconnected face-offs here: between the RBA and the major banks; and between the major banks themselves. No bank wanted to move first on its rates. Over the past two years, both
Westpac Banking Corp
and
Commonwealth Bank of Australia
copped vitriol for breaking from the RBA on an entire rate move.

National Australia Bank
took a shorter pounding for pocketing 0.05 of a percentage point of last month’s RBA cut of 0.25 of a percentage point.

Any such moves this time would provoke a cacophony of name-calling – if not any actual sticks and stones from government or regulators. No chief executive, no matter how much cushioning multimillion-dollar packages provide, enjoys that. And they know their staff cop the brunt.

But more significantly, the tension-filled wait for rate movements does reflect competition for market position – and margins.

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As European contagion has affected global debt markets and the cost of domestic deposits has risen, bank funding costs are higher. The RBA noted on Tuesday that “short-term market interest rates have tended to decline a little further in recent weeks, though term funding conditions for financial institutions have become more difficult".

While short-term rates have declined, retail deposits are not cheaper for the banks as the spread to bank bill rates – the key element of deposit rates – has widened. Deposits now represent just under two-thirds of the banks’ funding mix. Moreover, little offshore debt raising has taken place due to the chaos, but what has suggests those markets, too, are more expensive. And they will presumably be so even if confidence in a European solution improves and markets open up. The RBA has noted before it is aware its actions on the cash rate are not exactly mirrored in the wide world. Indeed, the RBA emphasises it takes commercial rates into account when setting the cash rate, attempting to allow for greater discounts or premiums on those rates. So the other game is the banks calculating whether the RBA might cut again if they don’t pass on this latest move.

The big banks are very profitable. Margins and return on equity are improving. They can afford to pass on the full cuts at this point but at a cost. The decision is at once tactical (what will their rivals do?) and strategic (to favour customers or shareholders?).

Last year, CBA went with shareholders and was savaged. Former chief executive
Ralph Norris
has maintained he would do the same again but the decision came with a real cost: CBA, long a laggard on customer satisfaction, had been winning back ground but the decision halted its momentum. (And by the by, cost senior executives bonuses linked to ­customer satisfaction.)

Ultimately, the banks can afford a full cut today but see before them an uncertain environment with inexorably rising costs, both commercial and regulatory. Against that is both competitive momentum and ferociously adverse publicity. So, to quote The Goons: “Suddenly, nothing happened. But it happened suddenly."